Madoff

Media reports say that amid the still unsettled regulations in the wake of the financial crisis, affluent investors are turning to behavioral specialists, looking to find things in the faces and phrases of their fund managers that may not be revealed in financial statements.

Eccentric screening techniques are nothing new to Wall Street. Seigmund Warburg, founder of the investment bank S. G. Warburg & Co., was known for subjecting customers and employees to psychological tests, and evaluating hand-writing samples of job applicants. And these days, requests for deception detection are on the uptick, as acknowledged by lie detector professionals who are turning down repeated orders to analyze subjects for Wall Street firms.

Earlier this year, intelligence sources disclosed to the publication Politico that the CIA, within tight guidelines of its employment policies, allows agents to moonlight in the private sector, and that some of them work as “human lie detectors.” Calling deception detection an “arcane field,” Politico reported that such experts recognize the verbal and nonverbal cues that indicate someone may be lying, and the people under scrutiny never know they’re being evaluated. Politico recounted an incident from 2005 where a large hedge fund, through a third-party, retained CIA-trained analysts to remotely listen in on a quarterly earnings status call from executives at UTStarcom. During the call, the agents noted some suspicious responses by the interim CFO, and specifically about revenue recognition. They subsequently cautioned that the company most likely would post poor results in the third-quarter. And sure enough, the prediction came true: a day after the below-expectations results were released, the stock closed at $5.64. It had been trading at $8.54 when the CIA listened in on the call in August.

So exactly what verbal clues tipped off the agents? In this case, it was a “detour statement” when the interim CFO qualified his response to a revenue recognition question by referring back to an announcement from a previous quarter, and avoided further comments on any related issues. The executives on the call also projected low confidence, had an underlying concern and did not readily come forth with information.

According to corporate lie detection experts, there is a myriad of verbal clues that may be indicators of dishonesty. Shifts in language patterns, such as switching from the first person to the third person, i.e., suddenly speaking on behalf of “the firm” or “the team,” and quick “rehearsed” responses may be red flags. Statements that contain the words “honestly,” “frankly” or “basically” and phrases such as “as I said before” and “I swear to God” also have been linked to deception. Attacking the questioner with “How dare you ask me something like that?” too may point to someone who is uncomfortable with the untruth, as well as having a selective memory as indicated by the phrase “to the best of my knowledge.” Additionally, complaints – “How long is this going to take?” – and overly courteous responses – “yes, sir” – have been found common in liars.

And of course there are physical indicators of lying, with the main ones being facial twitches, changes in breathing tempo, and dilated pupils. Professional human lie detectors say that people who are uneasy with deception will show that in motions such as micro-expressions—brief flashes of fear or other changes in a face—or concealing positions like crossing legs, or sitting motionless. Shifting anchor points, grooming gestures such as adjusting clothes, hair or eyeglasses, picking at fingernails, and cleaning the surroundings by straightening paper clips on the table or lining up pens are also possible indicators of honesty transgressions.

Skeptics, however, abound. In a May 2010 report, even the Government Accountability Office called into question the effectiveness and the scientific foundation of deception detection techniques. And many experts agree that even the most common dishonesty signs are not universal and detection is most effective when the analyst can establish an “honesty” pattern and then look for deviations.

When screening a fund manager, investors still like to see experience, a consistent record and good returns. And a comprehensive background investigation that provides such information may be more predicting of future behavior and honesty than a Pinocchio’s nose. But human lie detectors can identify “hot spots” for extra probing, and combined with a traditional due diligence, buy investors a reasonable peace of mind.